How To Hedge For A Market Correction With ETFs

Are we near the top or did the bull train just leave the station? Fundamental news has been bolstering equity markets higher since the start of 2012, although many investors are fearful that if they jump in now, the next market correction may very well wipe out all of their gains and then some. Luckily, thanks to the evolution of the ETF industry, investors who wish to dip their toes in the water without going “all in” so to speak have a number of valuable instruments at their disposal [see also Brent Crude vs. WTI: The Best Performing Commodity].

Some sophisticated investors may wish to employ options trading strategies to hedge for downside risk in their positions, while others commonly opt for safe haven exposure through gold or bonds. Newcomer QuantShares offers mainstream investors a creative approach to hedging for a potential correction while also easing the burden of market timing. The Boston-based issuer offers a suite of market neutral ETFs that are worth a closer look for anyone who wishes to lower their portfolio’s overall volatility through the purchase of a single ticker [see Special Report: Alternative ETPs In Focus].

The QuantShares ETFs profiled below are designed as hedging vehicles that can smooth out volatility by taking advantage of fluctuations in the market. Each of the products is market and sector neutral; these ETFs hold equal weighted, dollar neutral long/short positions, which means they can deliver positive returns in both bull and bear markets [see also Three Years Later: Best Performing ETFs Since Markets Bottomed Out].

This ETF holds long positions in the lowest beta stocks and short positions in the highest beta stocks. The thesis behind this strategy is that if uncertainty arises, lower beta securities will tend to outperform “riskier”, higher beta stocks. This approach may appeal to investors who anticipate an increase in volatility, but wish to avoid taking an outright short position in the market.

Consider the adjacent chart which shows the returns of the S&P 500 Index (red line) versus BTAL’s underlying index, the Dow Jones U.S. Thematic Market Neutral Anti-beta Total Return Index (blue line) [graph was compiled using daily returns data from Dow Jones Indexes]. Notice how during the stock market slump in 2008 the Anti-Beta Index was able to deliver massive gains, which certainly could have helped to offset losses in long-only equity portfolios.

This ETF undertakes the market neutral approach from a slightly different perspective. QLT buys stocks that have a combination of high return on equity and low debt to equity, while at the same time shorting securities with low or negative return on equity and high debt to equity ratios. The appeal of QLT is quite simple: quality stocks, based on fundamental criteria, have a tendency to outperform lower quality securities when volatility in the market increase since investors are scrambling for “safer” exposure [see QLT Fact Sheet].

NOMO delivers market neutral exposure by taking on a more technical approach in the security selection process. This ETF holds long positions in stocks that are deemed to exhibit low momentum characteristics, while simultaneously shorting the high momentum securities. The underlying portfolio is re-balanced monthly and could provide investors investors with a creative means of taking advantage of declines int he market. Additionally, many investors have unintended momentum biases which can be reduced by making an allocation to NOMO [see ETFs To Smooth Volatility: Looking At Some Long/Short Options].

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